Debenture is basically a form or format prepared for a long term debt or loan that the companies or firms used to take for borrowing money from the public. Though the borrowers agree to pay or refund the debenture amount to the lender after the completion of the tenure but still they often remain unsecured.The loan is usually secured by the companies or firm’s secured assets in India and most of the countries. However in the United States they remain unsecured.
Redemption of debentures means to repay or clear all the standing debts and loans to the debenture holder or the lender who gives the loan, basically settling the loan after the expiry of its tenure. It comes along with a set of terms and conditions agreed by both the parties on the matter of repayment of the loan or debts.
Redemption of Debentures is defined as the settlement of borrowed funds by a company or a firm to their debenture holders after the date of maturity. After the funds are repaid, the liability on the debenture account is discharged.
What is Debenture Redemption Reserve (DRR)?
A debenture redemption Reserve can be referred to as a provision which states that any company, firm or enterprise in the country which issues debentures are required to open a redeeming service of the debenture to show an effort to ensure repayment of borrowed funds.
As per the Indian Companies Act of 1956, all companies who issue a debenture need to create a debenture redemption reserve before the maturity date of a specific debenture. According to this Act, companies need to represent at least 25% of the face value of the issued debentures.
For example, let’s say that a company ABC Pvt Ltd. issues Rs. 20 lakhs in debentures on the 1st of April of 2020 with a maturity date of March 2025. Here, as per the companies act, ABC Pvt Ltd. needs to assemble 25% of Rs. 20 lakhs as debenture redemption reserve before the maturity date of the debenture.
Companies are not required to arrange funds for the debenture redemption reserve just after issuing the debenture. They are allowed to credit funds into the DDR account by an adequate amount each year until the maturity date.
Methods of Redemption Reserve
There are several methods by which the redemption of debentures can take place. Each method follows a unique accounting treatment. These approaches can be classified under the following categories :
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Payment in lump-sum on the debenture’s maturity.
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Payment in instalments after the maturity date.
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Redemption through the purchase of the debenture on the market.
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Redemption through the conversion of debentures into new debentures or equity shares.
For a clear understanding, check a tabular representation :
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Payment in Lump-Sum on the Debentures Maturity
In such cases, the debenture is redeemed by the company in a lump-sum amount as a one-time payment at the end of the maturity period. The amount, as well as the maturity date, will be as per the terms discussed during the issuance of the debenture.
As the company is aware of the date of maturity, they can prepare their finances in advance. This one-time payment of such a lump-sum amount also includes the funds set aside in the debenture’s redemption reserve account.
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Payment in Installments after the Maturity Date of the Debenture
In this method of redemption of debentures, repayment of the borrowed funds takes place through a series of installments in a regular or irregular fashion as per the terms of the conditions of the redemption of the said debenture.
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Redemption Through the Purchase of the Debenture on the Market
In this case, companies and firms are willing to purchase their debentures on the market. They can also choose to cancel them immediately; in such a way, the company can prolong the maturity of the debenture until the payment is suitable for its financial capabilities.
Moreover, if the purchase of the debentures on the open market is made at a discount, the company can avail the opportunity of lowering the overall redemption payment, thereby improving the overall business revenue.
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Redemption Through the Conversion of Debentures
Redeemable Debentures also offer the facility of conversion into a new type of debenture or an equity share of the concerned company. The terms and conditions of the conversion of such a debenture are addressed to the holder during the issuance of the debenture.
This kind of debenture is termed as convertible debentures. Such debentures are converted to new debentures, or equity shares can be issued by the company at par, for discount and even at a specified premium.
According to Rule 18(7) of the Companies Share Capital and Debenture Rules 2014 at least 15% of the face value of the debenture amount is to be redeemed during the year the company is making investments in specified securities. This is required to be done within the 30th of April of the maturity year.
Finally, companies should also keep in mind that the DRR account is required to be opened in any financial institution of the country which is authorised by the Reserve Bank of India.
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